Three reasons why crude at $40 can be booster for Indian market

NEW DELHI: The domestic equity market has managed to outperform other emerging markets (EMs) so far in calendar 2015, largely because of improved economic fundamentals and a crash in commodities, including crude prices.

India imports over 70 per cent of its crude requirement and, thus, falling crude oil prices would ease current account deficit and also significantly reduce the fuel subsidy burden, experts said. The expenditure on crude oil accounts for 30 per cent of India’s import bill.

“India is not exposed to the commodities universe unlike a number of other emerging markets, such as Brazil or Russia. Plus, the reform processes is also coming through. Some green shoots are probably evident in terms of how the project wins and project initiations have started at least on the government side,” Joshi said.

He said the market might remain largely rangebound over the next few months, but still India remains in a sweet spot.

The slowdown in global economies has impacted the demand side, which has resulted in a sharp drop in crude oil prices. But the India is net importer of crude oil. So any drop in crude price is beneficial for the domestic economy as our import bill goes down and the subsidy burden drops significantly.

Speaking at an event in the United Arab Emirates (UAE), finance minister Arun Jaitley recently said low crude prices have created a favourable environment for the Indian economy, as it has helped absorb the loss faced by public sector oil marketers and also contributed to the fall in inflation.

The near 40 per cent correction in crude prices so far in calendar 2015 to about $40 a barrel has been largely on account of a slowdown in the Chinese economy, as well as a supply glut.

“More than China, supply factors have played a larger role than demand factors in driving crude prices lower. The higher oil output was mainly because of non-OPEC developments such as a US shale gas boom and also higher-than-expected OPEC output in countries such as Iraq, Libya and Saudi Arabia,” said Nikhil Kamath, Director, Trading & Risk- Zerodha.

The crash in crude prices has been in tandem with the slowdown in the global economy, which has only expedited the fall. “No one factor can influence the direction of an economy as mammoth as ours, but we should definitely not ignore the fact that despite all the turmoil, India is outperforming most foreign economies at a healthy pace,” he said.

Sanjay Guglani, CEO, Silverdale Capital, said the basic reason why India has not gone through so much of pain is mainly because of the drop in commodity prices, specifically in crude prices. “One has to look at it in terms of medium-term to long-term plays and when the structural reforms take place,” he said.

We have collated a list of three factors that will aid the market going forward:

Improvement in CAD: India is a major importer of petroleum crude. Crude prices have declined 42.6 per cent over the past year, which has had a significant positive impact on India’s current account deficit. With the decline in crude prices on an annualised basis, India’s imports have fallen 21.2 per cent in October 2015 to $31.1 billion compared with $39.5 billion in the year-ago period.

Official figures show trade deficit in the first seven months of the financial year (April-October) has shrunken to $77.76 billion compared with $86.26 billion in the last financial year. “Lower crude oil prices will be certainly good for the Indian economy, as India imports nearly two-thirds of its crude oil requirements, spending $130 billion annually to meet its burgeoning oil demand,” said D K Aggarwal, CMD, SMC Investments and Advisors.

Going forward, India’s current account deficit (CAD) is likely to be about 1 per cent of the GDP in the current financial year because of low crude prices and contained gold imports, Citigroup said in a report.

According to the global financial services major, CAD is likely to be about $20.6 billion (1 per cent of GDP) in 2015-16 compared with $28 billion (1.4 per cent of GDP) last year. “Though it’s still early to call the bottom on export contraction, we maintain our view that India’s current account deficit will shrink to around 1 per cent of GDP in FY16 due to low crude oil prices and contained gold imports,” Citigroup said in a research note.

Sectors that will benefit: A fall in crude oil prices is particularly beneficial for sectors that use crude and crude derivatives as a raw material. Stocks of sectors such as paint, tyre, FMCG, airlines and lubricants will remain in focus.

“Sectors such as paint, adhesives, insecticides and specialty chemicals use many key raw materials that are correlated to crude oil prices,” says Tushar Pendharkar, Head of Research at Right Investment Advisory Services.

“Thus lower crude prices can sustain higher operating margins for companies in these sectors. In addition, heavy industries such as metals, cement, engineering and capital goods can sustain the control over power and fuel expenses,” he said.

Oil and gas upstream companies, independent oil explorers and oil rig operators would be impacted if crude prices stay at current levels for a long time. “The universe of stocks that will get impacted negatively is smaller compared with the number beneficiaries of lower crude oil prices,” said Jimeet Modi of SAMCO Securities.

“Stocks like Cairn India, ONGC, GAIL, Oil India, Reliance Industries and Aban Offshore are likely to be affected adversely if crude oil prices stay at these levels,” he said.

Outlook for crude oil: Crude oil will largely remain flat or hover around these levels with a slightly bullish bias, say experts. Commodities take far longer to bottom out as the demand-supply equilibrium needs to turn around, they say. Lower crude oil prices for the rest of the year would mean more strength in the macro-economy, which would act as a key to attracting foreign money.

“Supplies need to get absorbed while new supplies are not forthcoming due to low or no investment in exploration activities in the past. Generally, crude oil has a habit of consolidation of about two to three years before the prices turn up,” said Modi of SAMCO Securities.

Analysts expect crude oil to remain under pressure and move in a range over the next 12 months. But the $40-50 a barrel price level is very low to sustain, and it should ideally move higher, because for most of the oil producing countries, $80-90 is the break-even point.

“At current level, oil could benefit India in the short run. However, it won't help achieve strong economic performance in the long run. For most of the oil-producing countries, $80-90 is the BEP (breakeven point) and thus I believe oil would roam around this level in long run,” said Pendharkar.

Kamath of Zerodha expects crude prices to remain in the $ 35-55 range over the next 12 months. Apart from that US Fed rate cycle, geopolitical concerns are some of the factors that could affect future crude price trends.